If the government tries to observe financial discipline and avoids tapping into monetary resources to cover its expenses, we can be hopeful about the control of liquidity growth and inflation. In addition, the financial discipline of banks, both in asset and debt management as well as liquidity management, is the second necessary condition for controlling inflation.
Here, the Central Bank of Iran, as a supervisory body, should introduce precautionary regulations in banks and require the banking system to comply with them. Violation of regulations should also be strongly confronted by the monetary policymaker. These were stated by Kamran Nadri, an economic expert, in a write-up for the Persian daily Jahan-e Sanat. A translation of the text follows:
A change in the policymaker’s approach that replaces the government’s financial domination with the monetary domination of the central bank, and a replacement of the central bank’s financial domination of banks with its comprehensive and authoritative supervision have yet to materialize. Despite the awareness of the monetary and government officials about these issues, a specific plan to resolve this structural problem, either under the current CBI Governor Mohammad Reza Farzin, or the previous chairmen, has not been devised yet. Consequently, monetary inflation caused by the inappropriate growth of liquidity will persist in Iran’s economy.
Inflationary expectations should also be regarded as another factor affecting the growth of inflation. The government and the central bank might have restrained the growth of liquidity by adopting appropriate policies but given the high inflationary expectations in the economy, the containment of inflation is not possible. Inflationary expectations shift in accordance with positive and negative political news, and as a result, changes in this index are rooted in the country’s foreign policy.
For example, positive political news can prevent price fluctuations in the foreign currency market and this in turn can curb inflationary expectations and inflation. When inflationary expectations go up, the gap between inflation rate and liquidity increases and inflation grows at levels higher than liquidity.
The inflation rate of above 50% at the end of last year (March 20) compared to the 28% liquidity growth proves that inflationary expectations had the upperhand in paving the way for the growth of inflation over the growth of liquidity.
Inflationary Shocks
Shocks triggered by the government’s inflationary policies are another factor that leads to inflation. The sudden elimination of subsidized imports last June or the overnight increase in energy prices under the former administration of Hassan Rouhani are examples of price shocks whose consequences have persisted in the economy and impacted the prices of other items.
Therefore, inflationary expectations and shocks arising from government policies, besides the growth of liquidity, can be seen as the main reasons behind the growth of inflation in Iran. Note that the impact of liquidity growth on inflation is gradual, while the other two factors are quick to drive up the prices of goods.
In general, factors contributing to the growth of inflation can be categorized into two groups: First, liquidity growth, which is a structural factor in increasing inflation. The effect of this factor appears with a delay. The second factor, however, comes from the impact of fundamental developments in the country (foreign policy and political system) on non-economic policies, which can quickly affect the inflation rate by increasing inflationary expectations. Inflationary shocks affect the inflation rate also emerge from the government’s policies regarding the supply of essential goods supply (the pricing policy).
If the government fails to observe financial discipline and requires the central bank to comply with its financial policies (at present, government agencies such as the ministries of economy and agriculture, the Budget and Planning Organization, etc. have control over CBI, so much so that the central bank is implementing the financial policies of the government) and if banks continue to violate CBI’s precautionary regulations and finance their deficit via the central bank, inflationary expectations will not be controlled and price shocks will affect the economy.
In the long run, the inflation stemming from unrestrained growth of liquidity will not be contained and the inflationary effects of inflationary expectations will continue in the short term.
